McDonald’s Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results; amounts are in U.S. dollars. McDonald’s operates and franchises restaurants, and is shifting toward a more heavily franchised model. At quarter-end it had 37,011 restaurants, including 5,075 company-operated; its long-term goal is approximately 95% franchised.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $6.050B | $6.265B | $11.726B | $12.169B |
| Operating income | $2.295B | $1.858B | $4.329B | $3.638B |
| Net income | $1.395B | $1.093B | $2.610B | $2.218B |
| Diluted EPS | $1.70 | $1.25 | $3.17 | $2.51 |
| Cash provided by operations | $1.213B | $1.248B | $2.757B | $2.994B |
- Q2 revenue fell 3% (2% in constant currencies); six-month revenue fell 4% (3% in constant currencies). Company-operated sales declined 9% in both periods, while franchised revenue rose 6% and 5%, respectively, reflecting refranchising and sales growth.
- Global comparable sales increased 6.6% in Q2 and 5.4% for six months. Q2 growth was 3.9% in the U.S., 6.3% in International Lead Markets and 7.0% in High Growth Markets. Systemwide sales increased 8% in constant currencies in Q2 and 6% for six months.
- Operating income rose 24% in Q2 and 19% for six months; diluted EPS rose 36% and 26%. Prior-year strategic charges of about $230 million benefited comparisons. Excluding current-quarter and prior-year strategic charges, diluted EPS increased 19% in Q2 and 19% for six months (constant-currency increases of 21% and 20%). Lower depreciation on China and Hong Kong assets held for sale also benefited results; the six-month period additionally included a U.S. property-sale gain.
- Company-operated restaurant margin was 18.7% in Q2 versus 17.1%; six-month margin was 18.1% versus 16.3%. Six-month operating margin was 36.9% versus 29.9%. Results benefited from stronger operating performance, G&A savings and refranchising; stopped depreciation on China and Hong Kong held-for-sale assets benefited margins by about $40 million in Q2 and $82 million for six months.
- Interest expense was $231 million in Q2 and $450 million for six months, up 3% and 2%, respectively. Effective tax rates were 32.3% for Q2 and 32.5% for six months.
Cash, debt and liquidity
- Six-month operating cash flow was $2.757 billion, down from $2.994 billion, primarily due to working-capital changes, including higher incentive compensation and income-tax payments. Capital expenditures were $796 million; operating cash flow exceeded capital expenditures by about $2.0 billion.
- Six-month investing cash outflow was $9 million, with proceeds from restaurant-business sales contributing. Financing cash outflow was $1.754 billion, including $1.856 billion of share repurchases and $1.532 billion of dividends.
- Cash and equivalents were $2.392 billion at June 30, 2017, versus $1.223 billion at year-end 2016. Long-term debt was $28.151 billion and current maturities were $210 million; total debt obligations were reported as $28.4 billion, up from $26.0 billion at year-end. Management cited net debt issuance and currency translation as drivers.
- Total current assets were $5.893 billion and current liabilities $2.743 billion. Shareholders’ equity was a deficit of $2.001 billion. Management said the company generates significant operating cash and has substantial credit capacity. Estimated fair value of debt was $30.3 billion versus a carrying amount of $28.4 billion.
Material changes, outlook and notable items
- Refranchising is reducing reported revenue as company-operated sales convert to franchise fees, while management expects a more stable, less resource-intensive business. More than 90% of restaurants worldwide were owned and operated by independent local businesspeople following the July 31 China and Hong Kong transaction.
- On July 31, 2017, the company completed the sale of its China and Hong Kong businesses, comprising more than 2,700 restaurants, for $1.6 billion cash proceeds while retaining a 20% interest. It expected to record a pretax gain of about $1.0 billion, subject to final working-capital adjustments; this post-quarter gain is not part of Q2 results. China and Hong Kong results will be reported as an affiliate after closing.
- Management did not provide specific EPS guidance. For 2017 it expected net restaurant additions to contribute about 1 percentage point to systemwide sales growth in constant currencies; U.S. and International Lead commodity baskets to increase about 0.5%–1.5% and 2.0%, respectively; SG&A to decline about 7%–8% in constant currencies; interest expense to rise about 5%; and the effective tax rate to be 31%–33%.
- 2017 capital expenditure outlook was about $1.7 billion, with roughly one-third for new restaurants. Management expected about 900 openings and approximately 400 net additions. It targeted about 2,500 U.S. Experience of the Future restaurants by year-end 2017 and mobile order and pay in 20,000 restaurants, including 14,000 in the U.S.
- Management expected refranchising proceeds to fund share repurchases, but anticipated a negative EPS effect of a few cents per quarter through Q3 2018 from the weighted-average-share calculation. Currency exposure is material: management estimated that a 10% move in the Euro, British Pound, Australian Dollar and Canadian Dollar in the same direction would change annual diluted EPS by about $0.25.
- Other notable items: Taiwan business sale proceeds were about $150 million, with no significant closing gain or loss; Q2 included a loss on that sale. The board replaced its $15 billion repurchase authorization with a new $15 billion program effective July 28, 2017. The filing reported no material change in legal-proceeding disclosures and no material change in market-risk disclosures. Management said disclosure controls were effective; an ongoing third-party transaction-processing transition was not initiated in response to an identified control weakness.
Risks and contingencies
Key disclosed risks include failure to execute customer-growth, digital, delivery and restaurant-modernization initiatives; intense competition and changing consumer preferences; food safety and brand reputation; dependence on franchisee performance as refranchising expands; labor and commodity-cost pressure; foreign-exchange and economic volatility; supply-chain disruption; cybersecurity and technology outages; regulation, litigation and tax changes; and potential impairment or higher borrowing costs. The filing noted that investments in customer experience and technology may not earn expected returns. No clear quantified estimate of aggregate legal contingencies is provided in the supplied filing text.
Investor verification priorities
- Assess how much earnings growth reflects underlying operations versus prior-year charges, held-for-sale depreciation savings, property-sale gains and lower share count.
- Track refranchising’s effect on reported revenue, franchise margins, cash generation and the stated near-term EPS headwind.
- Verify the final China and Hong Kong sale gain, working-capital adjustment, retained-interest accounting and post-sale results.
- Monitor debt growth, interest expense, refinancing needs, and cash returned through dividends and buybacks.
- Test whether comparable-sales momentum and planned digital, delivery and Experience of the Future investments translate into durable guest-count growth and returns.
- Compare actual 2017 spending, restaurant additions, commodity costs, SG&A, tax rate and currency effects with management’s outlook.